China to overtake the U.S. economy

In the 1970s and 1980s it was Japan that was going to take out the United States as the economy of the future. Now the new kid on the block is China. Of course, we all know what happened with Japan, which now ranks as the third largest economy in the world. China has a different story and historical perspective can provide some guidance.

For nearly 500 years until 1830, China was the world’s leading economy with approximately 30% of global gross domestic product (GDP). The rise of Western Europe and America since the mid-1800s placed China in the middle of the pack. However, starting in the 1990s, China accelerated rapidly with its policy of autocratic capitalism. For example, China was the world’s ninth largest economy in the year 2000, and now 14 years later is ranked second, generating approximately $8 trillion in GDP.

However, recent headlines in leading world economic and financial publications such as the Economist magazine, Financial Times and The New York Times suggest China may take over the number one seed possibly this year. How could this be?

The International Comparison Program, hosted by the World Bank, just released new figures ranking world economies based upon purchasing power parity, or what money can buy. That is, the basic Chinese haircut is cheaper than the same haircut in the U.S. There is no pressure on market exchange rates to equalize because Americans do not travel to China just to get a haircut. Another way to approach purchasing power parity is the Big Mac index. McDonalds’ Big Mac has the same ingredients whether it is in Moscow, New York, or Beijing. Purchasing power is ascertained by how much of a currency it takes to purchase a Big Mac around the world.

Since the financial crisis, China has generated approximately 25% of global growth. However, despite this growth, living standards of Chinese are far below developed countries and are unlikely to catch up with people of the rich nations. Is the Chinese economic data accurate? Yes and no. Many financial leaders suggest China’s actual growth rate is lagging behind reported figures by looking at measures such as electrical use and money supply. In China there is also a large underground economy and local leaders will oftentimes overestimate growth rate figures to improve their chances of promotion within the party.

One aspect can be drawn from this analysis. China is a rising economic power and with that status it will become a bigger partner in world economic trade. It will require China to step up to the plate in environmental and social issues and they will be criticized by neighboring countries that are sometimes threatened, particularly in that region of the world.